Investment trusts can help individual investors to diminish the risk inherent in stock market investment through diversification. The idea is the same as the common-sense advice not to put all your eggs in one basket.

Investment trusts enable individual investors to share the cost of professional fund management and to allocate assets over a variety of underlying investments, thus reducing individual investors’ dealing costs and exposure to setbacks or failure at any one company. Please remember that share prices can fall without warning and you may get back less than you invest.

For example, The Mercantile Investment Trust aims to achieve capital growth through investing in a diversified portfolio of about 120 medium to smaller UK companies. JPMorgan Claverhouse Investment Trust seeks both dividend income and capital growth from a portfolio of between 60 and 80 large UK companies. It would be impractical for many individual investors to have direct exposure to so many different shares because of stockbrokers’ minimum dealing costs and other considerations, including tax liabilities.

DIVERSIFICATION TO DIMINISH RISK

Stock market volatility – or the tendency for share prices to fall or rise without warning – is an important risk for investors to consider. Even large and long-established companies’ shares are not immune from this risk, as recent setbacks at Centrica, Sainsbury and Royal Dutch Shell demonstrate. Each of these blue chips’ stock market valuation was negatively affected by, respectively, the threat of statutory fuel price controls, competition from cut-price supermarkets and the halving of the oil price.

Pooled funds, such as investment trusts, set out to diminish that risk through diversification. They spread individual investors’ money over large numbers of companies’ shares to reduce exposure to setbacks or failure at any one company or – in the case of international funds – any one country. Avoiding having too many eggs in one basket is a simple but effective way to cope with market volatility. As David Stubbs, Global Market Strategist at J.P. Morgan Asset Management pointed out: “When the going gets tough, it’s more important than ever for investors to diversify.”

KEEP AN EYE ON COSTS

Stockbrokers’ minimum dealing charges vary widely but these costs tend to reduce total returns to investors for the simple reason that any deductions by intermediaries diminish what is left for investors. This makes it difficult for all but the most substantial individual investor to build and manage a diversified portfolio of dozens of different shares. Helal Miah, investment research analyst at The Share Centre, said: “I think the biggest restriction to a diversified portfolio is transaction costs.”

By contrast, investment trusts offer a convenient and cost-effective way to gain exposure to a widely-diversified portfolio of equities or shares in different companies and – in the case of international funds – countries. Annabel Brodie-Smith, a director of The Association of Investment Companies, said cost-effective diversification is one of the fundamental attractions of investment trusts4. She explained: “When you buy shares directly you have to pay dealing costs and admin fees, which can eat away at the value of your investment. In an investment company, all the investors pool their money and split the admin costs. The investment company is managed by a professional fund manager who manages a diversified portfolio of typically up to 100 companies. An investor in an investment company will end up paying much less than buying shares directly5.”

Investment trusts offer a convenient and cost-effective way to gain exposure to a widely-diversified portfolio of equities or shares in different companies and – in the case of international funds – countries

CUT PAPERWORK AND KEEP THE TAXMAN AT BAY

Capital Gains Tax (CGT)6 can be a worry for investors because it requires records to be kept of the prices at which assets are bought and sold so that CGT liabilities can be assessed on profits exceeding £11,100 per person during the tax year that ends on April 5, 2016. This can be time-consuming as well as expensive but investment trust investors are spared some of the paperwork and cost, as Brodie-Smith pointed out: “Investors benefit from the tax efficiency of the investment company which does not pay capital gains tax every time it buys and sells shares.” Although investors may pay CGT on the sale of their investment trust holdings.

Like most shares, investment trusts can also be held in individual savings accounts (Isas) and pensions to minimise the proportion of income and capital growth that must be paid to the taxman and to maximise returns to investors. Pensions are long-term tax shelters and savers must be 55 years of age or older before they can withdraw funds7. Isas may be useful for shorter-term savings because there is no minimum age for withdrawals.

Isas are being reformed so that instead of being able to put up to £15,240 per adult during the 2015/2016 tax year into an Isa in total, savers can take out their money and put it back in within the same year without losing their Isa tax benefits – as long as the repayment is made in the same tax year as the withdrawal8. Please note that tax treatment depends on individual circumstances and may be subject to change in the future.

MORE FOR LESS

Investment trusts enable investors to obtain exposure to a wider variety of shares than might be convenient, cost-effective or tax-efficient for most individuals to do directly. The reason is that investment trusts enable individual investors to share the cost of professional fund management and to avoid some of the paperwork and tax liabilities that direct shareholding can generate.

Stock market volatility – or the tendency for share prices to rise and fall without warning – is an important risk for investors to consider. Diversification – or avoiding putting too many eggs in one basket – is a tried and tested way to help diminish that risk and maximise your exposure to the capital growth and income that shares can deliver.